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International Business
Chapter 5
International
Trade Theory
Why Is Free Trade Beneficial?
Free trade - a situation where a
government does not attempt to influence
through quotas or duties what its citizens
can buy from another country or what they
can produce and sell to another country
trade theory shows why it is beneficial for a
country to engage in international trade even
for products it is able to produce for itself
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Why Is Free Trade Beneficial?
International trade allows a country
to specialize in the manufacture and export of
products and services that it can produce
efficiently
import products and services that can be
produced more efficiently in other countries
limits on imports may be beneficial to
producers, but not beneficial for consumers
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What Is Mercantilism?
Mercantilism (mid-16th century) suggests
that it is in a country’s best interest to
maintain a trade surplus -to export more
than it imports
advocates government intervention to achieve
a surplus in the balance of trade
Mercantilism views trade as a zero-sum
game
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What Is Smith’s Theory
Of Absolute Advantage?
Adam Smith (1776) argued that a country
has an absolute advantage in the
production of a product when it is more
efficient than any other country in
producing it
countries should specialize in the production
of goods for which they have an absolute
advantage and then trade these goods for
goods produced by other countries
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What Is Ricardo’s Theory
Of Comparative Advantage?
 David Ricardo asked what happens when one
country has an absolute advantage in the
production of all goods
 The theory of comparative advantage (1817) countries should specialize in the production of
those goods they produce most efficiently and
buy goods that they produce less efficiently from
other countries
even if this means buying goods from other
countries that they could produce more
efficiently at home
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What Is The
Heckscher-Ohlin Theory?
 Eli Heckscher (1919) and Bertil Ohlin (1933) comparative advantage arises from differences
in national factor endowments
the more abundant a factor, the lower its cost
 Heckscher and Ohlin predict that countries will
export goods that make intensive use of
locally abundant factors
import goods that make intensive use of
factors that are locally scarce
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What Is The
Product Life Cycle Theory?
 The product life-cycle theory - as products
mature both the location of sales and the optimal
production location will change affecting the flow
and direction of trade
 proposed by Ray Vernon in the mid-1960s
 Globalization and integration of the world
economy has made this theory less valid today
 the theory is ethnocentric
 production today is dispersed globally
 products today are introduced in multiple markets
simultaneously
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What Is New Trade Theory?
 New trade theory suggests that the ability of
firms to gain economies of scale (unit cost
reductions associated with a large scale of
output) can have important implications for
international trade
 Countries may specialize in the production and
export of particular products because in certain
industries, the world market can only support a
limited number of firms
 new trade theory emerged in the 1980s
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What Are The Implications Of
New Trade Theory For Nations?
 Nations may benefit from trade even when they
do not differ in resource endowments or
technology
 a country may dominate in the export of a good
simply because it was lucky enough to have one or
more firms among the first to produce that good
 Governments should consider strategic trade
policies that nurture and protect firms and
industries where first mover advantages and
economies of scale are important
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What Is Porter’s Diamond Of
Competitive Advantage?
 Michael Porter (1990) tried to explain
why a nation achieves international
success in a particular industry
 Porter identified four attributes that
promote or impede the creation of
competitive advantage
1.
2.
3.
4.
Factor endowments
Demand conditions
Relating and supporting industries
Firm strategy, structure, and rivalry
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What Is Porter’s Diamond Of
Competitive Advantage?
Determinants of National Competitive Advantage: Porter’s Diamond
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Does Porter’s Theory Hold?
 Government policy can
 affect demand through product standards
 influence rivalry through regulation and antitrust laws
 impact the availability of highly educated workers and
advanced transportation infrastructure.
 The four attributes, government policy, and
chance work as a reinforcing system,
complementing each other and in combination
creating the conditions appropriate for
competitive advantage
 So far, Porter’s theory has not been sufficiently tested
to know how well it holds up
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What Are The Implications Of
Trade Theory For Managers?
1. Location implications - a firm should disperse
its various productive activities to those
countries where they can be performed most
efficiently
2. First-mover implications - a first-mover
advantage can help a firm dominate global
trade in that product
3. Policy implications - firms should work to
encourage governmental policies that support
free trade
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What Is The
Balance Of Payments?
 A country’s balance of payments accounts
keep track of the payments to and receipts
from other countries for a particular time period
1. The current account records transactions of
goods, services, and income, receipts and
payments
 current account deficit
 current account surplus
2. The capital account records one time changes
in the stock of assets
3. The financial account records transactions that
involve the purchase or sale of assets
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